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Towards a Capital Markets Union in Europe

Investment in companies and infrastructures, notably in SMEs, remains lower than during the pre-crisis period and continues to rely heavily on bank funding. The Commission therefore deems that the recent “Banking Union” proposal needs to be complemented with initiatives aimed at reducing this dependence on banks by fostering other market-based credit options.

Two recent Commission initiatives reflect this commitment, the most important one being the Commission´s ambition to create a true and fully integrated Capital Markets Union that will unlock funding for European businesses and boost growth in the European Union. The Commission’s second complementary flagship project, the “Investment Plan for Europe” aims to make available a new type of collective investment fund targeting investment in long-term projects.

1. Capital Markets Union

The Capital Markets Union (CMU) is one of the Commission´s top priorities. The CMU will comprise an action plan for improving financing of the economy through more efficient market-based instruments intended to complement traditional European banking tools.

Consultations for upcoming Capital Markets Union action plan (2015)

On 18 February 2015, the Commission launched a public consultation addressing the concrete hurdles to be removed for achieving a Capital Markets Union. The Commission simultaneously launched two distinct consultations: the first relates to high-quality securitisation while the second concerns review of the Prospectus Directive (the EU-wide regime for capital markets prospectuses required when a public offer of securities is made or when a company is seeking admission to a regulated market).

Interested parties have until 15 May 2015 to respond to the consultation and present their views and concerns to the Commission.

Based on the inputs provided during the consultation, the Commission is due to unveil during the third quarter of 2015 an action plan of operational proposals to be pursued.

The broad position of EU finance ministers is expected to be adopted at the ECOFIN Council next June.

Adoption of proposal to set new standards for financial benchmarks (2015)

On 13 February 2015, as part of its old regulatory reform agenda, the Council lent its support to the European Commission´s proposal for a regulation to combat the manipulation of financial benchmarks.

In the aftermath of investigations into manipulation of the LIBOR and EURIBOR benchmarks that undermined public trust in financial benchmarks, the Commission proposed new standards in September 2013 to strengthen the reliability of benchmarks used in financial instruments (e.g., bonds, shares, futures and swaps) and financial contracts (e.g., mortgages and consumer contracts).

This proposal of regulation is aimed at restoring market confidence in indices used as benchmarks for financial products and services, while implementing the same principles as those agreed at the international level by the International Organisation of Securities Commissions (ISCO) in 2012 and 2013. A benchmark is an index or indicator, calculated from a representative set of data or information, which is used to price a financial instrument or financial contract or to measure the performance of an investment fund.

These new standards are expected to do more to improve the accuracy and integrity of these benchmarks in three ways. First of all, contributors to benchmarks will be subject to prior authorisation and on-going supervision, depending on benchmark type (e.g., commodity or interest-rate benchmarks). Secondly, these new rules will improve the governance of benchmarks (e.g., conflict of interest management) and add further requirements in terms of how a benchmark is produced. Finally, the rules are meant to ensure appropriate supervision of “critical benchmarks” (e.g., Euribor and Libor), the failure of which may pose risks to many market participants and to the functioning and integrity of financial stable markets.

The European Parliament is still in the process of finalising its opinion on the Commission’s proposal. The EP’s opinion is not expected to be issued before June 2015, after which the EP will begin negotiations with the Council to reach a final agreement.

2. Investment Plan

On 10 March 2015, the European Parliament agreed to support the Commission´s proposal to create a new investment fund framework aimed at facilitating long-term investment. The proposal was endorsed by the Council in April and will soon enter into force following its publication in the EC official journal.

Setting up European long-term investment funds (ELTIFs) (2015-2016)

The recently agreed European long-term investment funds (ELTIFs) are designed to increase the amount of non-bank financing available to companies investing in the EU´s real economy. Currently, existing long-term investment funds are only to raise money in one Member State, which leads to fragmentation of the single capital market and limits the funds’ growth.

This new type of collective investment framework aims to boost financing available to companies in search of long term capital for projects related to energy, transport or even social housing, schools and hospitals. The intention is that investment fund managers will be able to offer long term investment opportunities to both institutional and private investors. Accordingly, the ELTIFs would constitute an important part of the Capital Markets Union (CMU) and complement the €315bn Junker´s landmark investment plan for Europe.

In order to benefit from this cross-border passport, these new fund vehicles would need to comply with strict rules aimed at protecting investors and the companies they invest in.

To qualify as an ELTIF, funds would need to invest at least 70% of their money within five years in specific projects, including: unlisted companies or certain listed SMEs in need of long-term capital, real assets for which development is dependent on long-term capital, intellectual property, and other intangible assets. The 30% buffer, however, may be held as UCITS-eligible assets.

In addition, these funds may only be proposed by a manager authorised under the Alternative Investment Managers Directive (AIFMD) and thus subject to AIFMD rules, including the obligation to have a depositary. Investors would not normally be entitled to have their funds returned to them for a specific period of time (e.g., at least ten years after their initial investment), thereby allowing for long-term investments in illiquid assets. This restriction, however, would need to be disclosed up front. In exchange for their patience, investors would be rewarded with a regular income stream and an appropriate return for committing their money.

ELTIFs differ markedly from UCITS, which must offer investors the chance to exit at least twice a month. However, as per specific and stringent requirements, ELTIF managers would be allowed to offer investors the option of withdrawing a proportion of their invested funds early, although only after five years. To avoid speculative use, ELTIFs may only use derivatives to manage currency risks in relation to the assets they hold, while the borrowable amount would be limited.

In addition, funds offered to investors such as pension funds would be required to provide additional safeguards, including a limitation on the amount that can be invested (up to 10% of assets under management).

Insights Brussels May 2015 - Capital Markets Timeline 2015 - 17

Insights Brussels May 2015 by MSLGROUP